Before the inlet of the computer science and
electronic data bases about stock exchange activities, the only way of
spotting securities that had known good returns compared to the market was
to use technical analysis charts. The Internet growth now allows to use
without expenses the search engines which sort and classify all the
securities of a market according to the criteria of your choice. Among these
criteria, there is, of course, the momentum of each security or, if you
prefer, its return over the last 3, 6 or 12 months (the periods depend on the
options offered by the security screener).
For instance, security screeners like the Yahoo!
Finances one or the Globeinvestor one make it possible to obtain
instantaneously, without the use of any chart, a selection of the 10 or 20
securities which have enjoyed the strongest price growth over the last 6 or 12
months. With this information very valuable to technical analysts you can
henceforth combine any factor suitable for the fundamental analysis. Thus,
you could ask to screen out the 10 securities which have known the best price
increase over the last 12 months, but only within the category of the
securities which have a price/earnings ratio lower than 12.
Investor who builds this kind of portfolio will
be considered by the ones as a technical analyst and by the others as a
fundamental analyst. However, it is neither one nor the other or, if you
prefer, it is both at the same time, because it seeks securities which have
a very good stock price momentum, but which, at the same time, constitute
good bargains in the market. Thus, the security screeners available on
Internet make it possible to have the best of the two worlds, i.e. to
combine criteria of technical analysis with criteria of fundamental
analysis. Better still, these new search engines enable you to be a
systematic investor, because all the securities from one or several stock
exchanges will be filtered by your grid in order to retain only the
candidates which match the admission criteria.
North-American investors are not yet aware of the
revolutionary impact of these Internet research tools. They start
gradually using these instruments, but without knowing exactly all the
rigour and all the depth they can provide to their investment strategies.
Moreover, I do not see a better way of investing than to marry the technical
analysis with the fundamental analysis to thus extract the best of the two
approaches and to obtain the maximum from it. The most serious and
disciplined technical analysts study a hundred charts a day. Even if they
think that they have a sufficient sample to apply their investment strategy,
it is not the case. The Internet security screeners filter in a few seconds
more than 5000 securities. There is no possible comparison, in this case, if
your strategy includes 5 or 10 selection criteria. In such a case, there
would not be enough of 100 technical analysts to reach a comparable result.
Since the beginning of the bull market of the
90s, the momentum approach has taken a good place among the classical
approaches based either on the value of the securities, or on the growth of
the companies. As indicated by its name, the momentum approach bets on the
securities which enjoy a strong uptrend. That means, for the ones, that it
is necessary to buy the securities which have known the strongest
appreciation of their stock price during the last months. For the others,
the point is to buy the company securities which have known the strongest
profit growth during the last three, four or five years. One can believe, at
first sight, that there are two different schools inside the momentum
approach. But I'm rather inclined to think that these are two distinct
approaches which have taken the same label. Hence, confusion reigns here.
Moreover, the approach known as earnings' momentum can be seen like one
implementation of the growth seeker school, no more.
These two strategies have in common that the
securities which enjoy a strong price appreciation are often those which
record a spectacular growth of their profits. However, investors who
capitalize on the earnings' momentum do not explicitly seek the securities
which have the most enriched their shareholders for the last year. They
prefer to focus on the companies which declare profits higher than analysts'
expectations or for which analysts upgrade their earnings forecasts.
The approach which bets on the stock price momentum
is in my opinion the most singular of both, because it has a rather original
characteristic and a very precise objective: to find in the market the
securities which have recently been broadly praised by the investors. Such
securities can easily have generated returns of 100%, 200% or even 300%
during the last 12 months. Of course, it is not the point to hope as much
for the months to come, but simply to benefit from the trend and to know
when to exit before it breaks.
Before the inlet of Internet and electronic stock
exchange data bases, the momentum approach was only reserved to technical
analysis followers. Today, any investor can adopt a momentum approach,
without to know anything about technical analysis. It is enough to have a
micro-computer and to be connected to the Web.
In spite of the major technological innovations that
Internet brings, several psychological barriers slow down the interest of
the individual investor towards the values which knew a very strong rise
during the last months. The average investor behavior in front of values in
full momentum is to believe that they are highly speculative securities or
to think that these values have already generated their full potential of
capital gain and that there is no more available margin for additional gain.
The resistance is strong and the strategy will not suffer so early from an
excess of popularity.
However, the university research of these 10 last
years is unanimous to recognize that the securities which knew the strongest
appreciation of their stock exchange price in the last 6 to the 12 months
tend to beat the market the next 6 to 12 months. This observation is valid
as well for the European Community countries as for the Canada and the
United States, no matter the size of the companies and the type of
Mark Hulbert, an analyst of the American financial
letters and one of the well-known chroniclers of the Forbes magazine,
observed that the financial letters which deliver the best returns for their
subscribers have a strategy strongly centered on the momentum of the stock
exchange prices. One can obviously quote the case of the Value Line letter,
but it could also be added to the list letters like the MPT Review of Louis
Navellier and OTC Insight of Jim Collins.
James O' Shaughnessy, author of What Works on Wall Street and mutual fund
manager, is one of the most active promoters of the investment strategies
which are based on the stock exchange price momentum. Its strategy,
applied in the Canadian markets, consists in buying the 25 or 50 Toronto
Stock Exchange securities which have risen the most for last year. It
renews the portfolio once a year, and it checks that the selected
securities respect the three following criteria:
1. Yearly earnings higher than last year.
2. A price/sales per share ratio lower than 1,5.
3. Sufficient volume to renew the portfolio in less
than 20 days.
All things considered, O' Shaughnessy makes a good
mix of technical and fundamental analysis.
An investor as James O' Shaughnessy only renews his
portfolio once a year. Its strategy is simple, disciplined and requires from
the investor only a few hours per year to manage his portfolio.
What Works On Wall Street
James P O' Shaughnessy
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